Why Dividends Are Better Than Stock Buybacks
- July 22, 2010
- Dividend Investing, Dividend Stocks
- 1 comment
This year is shaping up to be the “year of the dividend”. Already 10 stocks have initiated dividend programs this year. In addition, 142 companies have increased their dividends in 2010 versus only 1 stock that has reduced their dividend payment.
While some argue that it’s actually bad news when a company announces a big dividend, we at eDividendStocks.com believe that big dividends are good news! A dividend program demonstrates that a company has a high level of confidence in their future cash flows.
One question that we do hear quite frequently from investors is why are dividends better than stock buybacks?
In theory, a company that uses its cash to buy back its own shares should be just as beneficial to investors as paying them a dividend. Unfortunately, real-life experience shows that stock buybacks don’t benefit investors near as much as paying a dividend.
When a company announces a massive stock buyback it always makes big headlines. The company promises to spend millions or even billions of dollars to repurchase their shares and management hopes that this announcement will convey to investors that the company feels their stock is undervalued.
Unfortunately, these stock buyback programs are often more bark than bite. Many times companies don’t specify when they will repurchase their shares and these programs often drag on for years. Ideally companies would be repurchasing their own shares when the stock price is low. However, companies are often paralyzed by fear when their stock price is dropping and often seek to conserve cash. So when the stock price is low, the company isn’t actually buying their own stock. Many investors fail to even notice that a company has stopped or slowed their share repurchases, but it is headline news if a company decides to cut or eliminate their dividend.
Research has shown that most stock buybacks occur near stock market highs. Management is notoriously bad at picking the right time to repurchase shares. This ends up being a very inefficient use of cash. After all, if an investor wanted to purchase more shares they could do so on their own.
Another reason why dividends are better than stock buybacks is that stock repurchases are generally a one-time event, but dividends represent an ongoing commitment. Stock buybacks may not be executed until months later and sometimes are never executed, but a regular dividend is paid out each quarter.
With new dividend tax rates set to climb dramatically next year, investors may see stocks shift more to stock buyback plans. This is unfortunate because investors are generally better served by receiving a quarterly dividend than by having the company repurchase stock for them.
“In theory, a company that uses its cash to buy back its own shares should be just as beneficial to investors as paying them a dividend. ”
Yes indeed. That is the theory, or rather the hypothesis. Unfortunately, it simply is not the truth.
Stock buybacks are not the same as dividends, despite what corporate execs claim. ( See: http://capital-flow-watch.net/whesf )
However, stock buybacks are hard to understand, especially since 1983 when SEC Rule 10b-18 gave safe harbor to this form of market manipulation, and since accounting rules allow buybacks to be posted directly to capital accounts, rather than to profit and loss, even when the purpose is to give value to executive stock options.
The flaw in the ‘buybacks are a form of dividend’ argument is that you have to sell your stock to get the ‘dividend’. Ordinary investors have to pay for the stock they sell, but corporate execs get them essentially free through stock options. Real dividends are paid equally to all shareholders and are paid with or without any action on the part of the shareholders. Many investors can’t sell their stocks to ‘benefit’ from these ‘buyback dividends’, either for tax reasons, or because the stock or tied up in a trust, or litigation, or whatever.
Also the ‘enhanced EPS’ for those that don’t sell is also bogus. See: ( http://capital-flow-watch.net/lym ).
Note: the value of buybacks since 1983 in current dollars has been about $5.7 trillion dollars.
However, since this gigantic fraud has been going on for over thirty years making many people very rich, while the investing public is largely ignorant of what is going on, I don’t expect any great awakening among investors any time soon.